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capital budgeting
Fixed cost
Duration of production
Discount rate
Uncertainty
Market size
Other factors?
Fixed cost
The necessity of fixed cost
The ability to obtain resources and generate
revenues require initial fixed investment
Examples
Parental investment
Education
Project investment
Fixed cost: 1
Variable cost: 80% of output
Value per unit output: 1
Size of output: 10
Profit:
(1-0.8)*10-1= 1
10*(1-0.5)*30-100 = 50
Duration of production
A project lasts for some time. How to
choose duration of production?
Benefit of long duration
Initial investment can be utilized for a long
time
Discounting
Cash flows at different points of time need
to be measured with discounting.
The determination of discount rates is the
most difficult problem in finance.
We will spend most time on this problem
in this course.
Answers
12% discount rate
Project 1: 1.3
Project 2: -0.22
5% discount rate
Project 1: 5.44
Project 2: 7.02
Answers
5 years
Project 1: 2.99
Project 2: 1.65
10 years
Project 1: 17.99
Project 2: 26.65
Other factors?
Liquidity, fixed cost and discount rate
If you can not sell a project easily and have to
operate the project yourself during its entire life,
what kinds of fixed cost and discount rate you
will choose?
If you can sell a project easily, what kinds of
fixed cost and discount rate you will choose?
MBS and financial crisis.
Other factors?
External financing
Debt financing
Public debt: Issuing cost as fixed cost, generally lower
interest payment, more information release
Bank financing: No issuing cost, generally higher
interest payment, less information release